Purchase Solution

Global Risk Management of Hedge Values and Arbitrage Opportunity

Not what you're looking for?

Ask Custom Question

Please work problems; formula and showing how to solve problem are most important (so I can see how to solve similar problems). Thanks

American Airlines is trying to decide how to go about hedging â?¬70 million in ticket sales receivable in 180 days. Suppose it faces the following exchange and interest rates.
Spot rate: $0.6433-42/â?¬
Forward rate (180 days): $0.6578-99/â?¬
Euro 180-day interest rate (annualized): 4.01%-3.97%
U.S. dollar 180-day interest rate (annualized): 8.01%-7.98%

a. What is the hedged value of American's ticket sales using a forward market hedge?

b. What is the hedged value of American's ticket sales using a money-market hedge? Assume the first interest rate is the rate at which money can be borrowed and the second one the rate at which it can be lent.

c. Which hedge is less expensive?

d. Is there an arbitrage opportunity here?

e. Suppose the expected spot rate in 180 days is $0.67/â?¬, with a most likely range of $0.64-$0.70/â?¬. Should American hedge? What factors should enter into its decision

Purchase this Solution

Solution Preview

a) The hedged value of American's ticket sales using a forward market hedge is 0.6578 x 70 million = $46.046 million. (We have used the forward rate for sellers)
b) The hedged value of American's ticket sales using a money market hedge is 70 million x 0.959 (remember the Euro -180- day interest for borrower is 4.10%) = 67.13. this needs to be multiplied by the spot rate for the seller of Euro that is 0.6433. = $43.184 million.
c) The forward market hedge is less expensive.
d) Yes. There is an arbitrage ...

Purchase this Solution


Free BrainMass Quizzes
Balance Sheet

The Fundamental Classified Balance Sheet. What to know to make it easy.

IPOs

This Quiz is compiled of questions that pertain to IPOs (Initial Public Offerings)

Basic Social Media Concepts

The quiz will test your knowledge on basic social media concepts.

Employee Orientation

Test your knowledge of employee orientation with this fun and informative quiz. This quiz is meant for beginner and advanced students as well as professionals already working in the HR field.

Business Processes

This quiz is intended to help business students better understand business processes, including those related to manufacturing and marketing. The questions focus on terms used to describe business processes and marketing activities.